Short for an initial coin or token offering, “ICO” has become a common buzzword thanks to the cryptocurrency revolution.

But consumers should be cautious if they are considering investing in an ICO because a lack of regulation in this space worldwide has resulted in a sharp increase in fraudulent activity.

Here in Bermuda, the House of Assembly passed legislation on April 27 that seeks to regulate ICOs in Bermuda. The legislation now needs both Senate approval and royal assent in order to become effective. This move is part of a larger plan for Bermuda to become a global leader in the cryptocurrency arena.

The legislation passed in Bermuda requires that the minister’s consent is obtained prior to any ICO being launched and sets out minimum disclosure requirements for white papers, among other things. It also provides for severe penalties for anyone in breach.

An ICO raises capital for a business using blockchain technology by offering investors digital coins or tokens (virtual currency) in exchange for either cash (e.g. US dollars) or an existing virtual currency (e.g. bitcoin). Because virtual currency is not an interest in the company itself, it does not fit within the standard definition of “securities” (which includes shares) in most jurisdictions. Accordingly, ICOs are not subject to existing laws and regulations that govern the raising of capital through the traditional offering of securities.

If you are considering investment in an ICO you should apply the same principles employed when considering traditional investment opportunities. In particular, there are key questions you should ask to determine whether an ICO is legitimate or potentially fraudulent.

A legitimate ICO will clearly explain the underlying project and business strategy in its “white paper” so that it makes sense to its intended audience. It should also set out historical milestones and short and long term objectives. If a white paper presents anything less than this, it is an early indicator that the ICO and proposed venture may be fraudulent.

You should also consider whether the problem the product or service is purporting to solve makes business sense. Many ICOs sensationalise their project without substantiation through strategic marketing language. Investors should safeguard themselves against this tactic by ensuring that they understand the product or service, how it works and search for external third party scrutiny of the claims being made.

Be sure to assess the web presence of the ICO and its promoters. The less information available on the ICO website or internet generally, the more an investor should be concerned. On the other side of the coin (no pun intended) ICO promoters are also aware that even the most amateur investor looks to tick certain boxes before investing. With this in mind a fraudulent ICO may present a talented team of developers and advisers, using fictitious yet extremely embellished biographies along with stolen or stock images of real people.

It is critical to research each member of the team and evaluate their experience and history: check LinkedIn profiles and previous employment and educational institutions; contact the team to ask the serious questions; and review social media and blockchain community forums to obtain knowledge of their following and the current talk about the ICO (if any).

It is common for ICOs to engage in pre-mining before launching an ICO. Pre-mining is the practice of offering virtual currency to a small group of individuals, such as the founders, initial investors and developers, before the sale is made available to the public. Check how much of the virtual currency is being reserved for these individuals and ask whether the ICO is being conducted to raise funds for the project or the founders.

Also check where invested funds will be held until the virtual currency is issued. Between an investor’s payment and the actual issuance, a professional escrow agent could be used to safeguard against a promoter disappearing with the funds.

Any guarantee or promise of exorbitant returns on investment should be considered with scepticism. As with any investment, if it sounds too good to be true, it probably is.

As investors, we must not forget that we are responsible for our own financial wellbeing and so due diligence is critical and should be carried out with equal or even greater depth as when carried out for traditional investments with or without regulation.

Thankfully, government officials in Bermuda have worked collaboratively with legal and regulatory professionals as well as industry to develop a legal framework and regulatory regime that seeks to protect both consumers and Bermuda’s reputation as a leading international financial centre.

Bermuda’s ICO legislation is being touted by some as the new global standard for regulating ICOs and the virtual currency sector.

That is good news both for Bermuda’s global standing and for consumers considering an investment in this exciting and growing space.

• Attorney Alexis Haynes is an associate and a member of the Corporate Team at Appleby. A copy of this column is available on the firm’s web site at www.applebyglobal.com.

• This column should not be used as a substitute for professional legal advice. Before proceeding with any matters discussed here, persons are advised to consult with a lawyer